Exam asset pricing
Vrije Universiteit Amsterdam
27 October 2017
Question 1: The Basics
The main goal of financial markets is to channel scarce capital to its most productive use.
a. Explain how market efficiency affects the outcome of this process.
When markets are efficient, capital flows to its most productive use. When there is mispricing, market
prices do not reflect economic value. Therefore, there is also inefficient allocation of capital thus lower
economic growth.
The article below is taken from Bloomberg:
b. Explain whether this news about Tesla constitutes idiosyncratic news or market news.
Idiosyncratic. Company specific, because related to own production process.
Imagine you want to test whether the interest rate spread is priced in the cross section of stock returns,
and you want to do this using the Fama-Macbeth method. Your dataset consists of 1.000 stocks over 50
years.
c. Explain how many cross-sectional regressions you need to run for this test.
If you take 5 years to estimate betas(rolling), there are 45 years left. 45 years * 12 months = 540 cross-
sectional regressions
Vrije Universiteit Amsterdam
27 October 2017
Question 1: The Basics
The main goal of financial markets is to channel scarce capital to its most productive use.
a. Explain how market efficiency affects the outcome of this process.
When markets are efficient, capital flows to its most productive use. When there is mispricing, market
prices do not reflect economic value. Therefore, there is also inefficient allocation of capital thus lower
economic growth.
The article below is taken from Bloomberg:
b. Explain whether this news about Tesla constitutes idiosyncratic news or market news.
Idiosyncratic. Company specific, because related to own production process.
Imagine you want to test whether the interest rate spread is priced in the cross section of stock returns,
and you want to do this using the Fama-Macbeth method. Your dataset consists of 1.000 stocks over 50
years.
c. Explain how many cross-sectional regressions you need to run for this test.
If you take 5 years to estimate betas(rolling), there are 45 years left. 45 years * 12 months = 540 cross-
sectional regressions
